“I’m still paying off undergrad debt, so you don’t need to tell me college is expensive. Tell me how a 529 plan will help put my kid through college.”
You’ve likely heard of these, or were even a beneficiary of one, but if it slipped your now sleep-deprived brain, a Section 529 State Education plan- also called a qualified tuition plan- grows your baby’s savings in a tax-advantaged investment account. Your contributions to the account are not tax-deductible, but the tax-free withdrawals can be used for “qualified higher education expenses,” like tuition, room and board, books, and more recently, computer technology. Each state sponsors its own 529 plan, but you can shop around for one that offers the investment options you like more. You also have the opportunity to switch plans once a year.
You can choose from two types of 529 plans:
Savings plans: Work like your 401k or IRA- you invest your contributions in index or mutual funds. Savings plans are a flexible option, and you can choose from both in-state and out-of-state plans. The downside is that the value of your investment can fluctuate with the stock market and like your other investment vehicles, your savings aren’t federally insured or guaranteed by the state government; but overall, your savings will grow over time.
Prepaid tuition plans: Like the name implies, you can pre-pay all or part of in-state college tuition as credits at their current going rate, no matter how high tuition jumps when your child reaches college age. What’s the catch? With a pre-paid plan, you’re limited to certain colleges in the state you reside, which may or may not be where your child would eventually like to attend. If you choose to rollover to an out-of-state prepaid plan, you may not get your entire contribution back.
Though your child is the beneficiary of the 529 plan, you retain control of the account- so if you worry that your wild and crazy Benjamin Beneficiary will spend your savings on fraternity pledge dues and parties, he’s not allowed to access the account. If you withdraw money from your 529 and spend it on your child’s college tours, for instance, or another non-qualified expense, your cash is subject to income tax as well as a 10% penalty. Sound familiar?
If Benjamin Beneficiary decides to skip college and pursue his startup dream in Silicon Valley, you can rollover the 529 plan to another college-bound beneficiary without any tax consequences. And you can keep your fingers crossed that Benjamin's startup is the next Snapchat.
This article is 1st in the How to Save For College Series